Investors in commercial real estate may feel as though they have entered an entirely different market when compared to residential investing. Similar concepts exist; however, some of the rules are different. This article will be helpful as a transition guide for investors transitioning from residential investing into commercial property to assist them with making their first commercial property investment decision.
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Commercial Property is Different Than Residential Property
Commercial property will behave like a business. The income of the property will depend upon the leases, the quality of the tenants, and the cost of running the building. Capital expenditures work to keep the building functional, which will also impact the ability to generate income. Compared to residential property, commercial vacancies generally remain vacant for a longer period of time; however, the length of the vacancy may be offset by the length of the lease term.
Determine What You Want Your Commercial Property To Do For You
Before you begin reviewing potential listings, it is helpful to slow down and identify what you want your commercial property to do. Are you seeking consistent income from established tenants in markets with stable demand? Or are you willing to accept a greater level of risk and uncertainty, provided you believe there is a realistic opportunity to increase rents or “reposition” the asset? Once you determine your goals, you will have defined parameters for the location, the type of tenant, the loan terms, and the holding period. This will provide you with a clearer picture of what you need to achieve and assist you in declining opportunities that do not meet your objectives, regardless of how attractive the numbers appear on the surface.
Creating A Simple Deal Filter
A deal filter is a fast and easy tool to determine if you should spend time researching a property. First, the investor will build a simple spreadsheet that lists expected income, an allowance for vacant space, operating expenses, and loan terms. Next, test some quick assumptions, such as a very low rental price, some additional vacancy, and a slightly higher interest rate on the loan. As long as the numbers do not “go south” the property will continue through to be reviewed in more detail. If the numbers decline, then the property will be eliminated from further review.
Using Your Financial and Tax Knowledge to Find Potential Loans
Initial discussions with potential lenders provide you with the opportunity to gather valuable information on possible loan amounts, interest coverage, and the amount of equity required. Additionally, an initial conversation with your tax advisor will enable you to understand which legal structures and tax incentives are available that will increase your after-tax income, including whether there is any bonus depreciation available. Agents, managers, and building inspectors who have experience in the area can provide knowledge and insight into the local market for rentable properties, the history of maintenance of the property, and what capital improvements will be needed in the future. This information is typically much cheaper to obtain than the financial losses that could occur from the lack of this information.
An investor who understands how these assets earn income, sets clear goals, and runs each potential purchase through a simple model is ahead of many competitors. They are focusing on whether a specific property can stay resilient under ordinary pressure. This approach will not remove risk. It can, however, make the step into commercial property measured, informed, and aligned with the investor’s broader financial plans.
